Madison Core Bond: Flexibility within a Risk Managed Framework

A. March 2020

Increased credit exposure.

As the COVID-19 crisis began to unfold, corporate bond spreads meaningfully repriced. Bonds from very high-quality companies began to trade at significantly discounted levels, compared to just a few months prior.

As a result, our comfort with owning corporate bonds increased significantly. In late March 2020, our credit committee made the decision to move from an underweight to credit to a significant overweight. Over the following months, our strategies were able to purchase significant positions in high-quality corporate bonds at very attractive levels. We also focused on longer maturity bonds to further increase the potential impact of tightening credit spreads on the fund.

 

B. November 2021

Shortened Duration to reduce interest rate risk.

Our view during the latter part of 2021 was that the Federal Reserve would begin a normalization process of monetary policy in 2022. Historically, interest rate increases by the Fed to reduce inflation would end with the Federal Funds rate exceeding the level of inflation, thus creating a positive real Federal Funds rate at the end of the cycle. As 2022 began, the market was still pricing in a Federal Funds rate of only 1.75 to 2.00% by the end of the year, well below the inflation levels at that time.

 

C. February 2022

Reduced MBS exposure.

Early in 2022, the Federal Reserve indicated a desire to normalize monetary policy by raising interest rates in conjunction with a reduction in the amount of bond purchases (quantitative easing), especially mortgage-backed securities (MBS). Our view was that the economic-sensitive buyers would demand higher yields to purchase MBS versus what non-economic buyers would demand (the Fed). As the year progressed, the market began to realize that, indeed, higher spreads and yields would be needed before buyers would step in.

Our active, relative value approach flagged this mispricing, and as a result, the strategy held far fewer MBS. Those that we did hold demonstrated better risk characteristics. Eventually, MBS spreads widened to levels not seen since the 2008-2009 financial crisis. In late 2022, the strategy began to allocate to the sector, as the relative level of interest rates drove these securities to trade at historically significant discounts. As interest rate volatility diminishes, we expect the relative attractiveness of mortgage-backed securities to draw buyers back into the market.

 

D. March 2023

Added MBS exposure.

During the second quarter of 2023, due to liquidity issues within the banking sector, spreads on MBS widened significantly. Investors feared a large amount of selling by banks to raise cash in case of deposit flight. Additionally, quantitative tightening continued, thus increasing MBS supply to the market.

Our view was that the current level of spreads provided value both on an absolute and relative basis. The level of pricing would attract flow from investors, given the relative underweight to the asset class. Additionally, the Fund was underweight low coupon MBS due to Fed and bank ownership leaving spreads too tight. Low coupon MBS was the area of the market that widened the most, allowing the Fund to buy bonds with attractive characteristics and low payups.

 

E. January 2024

Began to let corporate exposure drop and added to MBS.

Despite persistent inflation and the threat of recession, corporate bonds were priced to perfection and not reflective of any economic or market shock. Spreads ground to historically tight levels in early 2024, and we actively reduced our exposure to corporate credit. Within our shrinking allocation to corporates, we maintained an overweight to Financial corporate bonds, which offered greater yields than similar-maturity Industrials for much of 2024. As corporate exposure drifted lower, we continued to add to asset-backed and higher-coupon mortgage-backed securities, which offered higher yields without sacrificing quality.

 

F. April 2025

Added credit exposure.

The tight credit spread environment of 2023-2025 provided a brief reprieve in the first half of 2025 as trade policy introduced uncertainty and subsequent market volatility drove corporate bond spreads momentarily wider before tariff threats were quickly paused or walked back. Though the window was short, we were able to actively add credit exposure. We maintained our overweight to mortgages given the attractive risk/reward profile and improved portfolio quality given relative valuations.